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Markets
A market is an assortment of institutions and infrastructures where people trade goods and services which all build an economy. The United States trading their coal for bananas from Honduras is a functional example of an international market. The bananas are a US import while the coal is a US export. The exchange of oranges from Florida for potatoes from Iowa is an example of a national market. Finally, a small fruit shop in Seoul trading with a local organic farmer for Korean pears is a typical local market. Price '''is what drives markets and makes them allocate which resources where in a free market economy. When the government steps up and takes control of resources, it controls price which can lead to inefficiencies. Rationing Systems =Market Structure= ''Main article: ''Theory of the Firm • Brief descriptions of Perfect Competition, Monopoly and Oligopoly as different types of market structures, and monopolistic competition, using the characteristics of the number of buyers and sellers, type of product and barriers to entry Demand •Definition of Demand * The willingness and ability of buyers to puchase different quantities of a good at different prices during a specific time period. In more general terms, demand is the relationship between the price of a good and the quantity demanded of that good. Also, demand can be said as the wants of consumers, either high or low. * '''Law of Demand with diagrammatic analysis The Law of Demand states that as the price of a good increases (decreases) the quantity demanded of that good decreases (increases). • Determinants of demand: There are six determinants of demand. 1.' '''Change in income (inferior goods): As income increases, the demand for inferior goods decreases. As income decreases, the demand for inferior goods increases. Ex: You have a second job, and your income increases. You go buy an old used car. That car is an inferior good, because you don't really want it but it saves you money. Change in income (normal goods): As income increases (decreases), the demand for normal goods increases (decreases), ceteris paribus. 2. Expected price of a good or service tomorrow: If the price of a good or service is expected to increase tomorrow, the demand for that good or service today increases. If the price of a good or service is expected to decrease tomorrow, the demand for that good or service today decreases. 3. Preference of a good or service: As the preference of a good or service increases, the demand for that good or service increases. As the preference of a good or service decreases, the demand for that good or service decreases. 4. Price of complement in consumption of a good or service: As the price of a complement in consumption of a good or service increases, the demand for that good or service decreases. As the price of a complement in consumption of a good or service decreases, the demand for that good or service increases. Ex: Complement Goods: Tennis Rackets with Tennis balls. If tennis racket price increase it would decrease tennis balls. 5. Price of substitute in consumption of a good or service: As the price of a substitute in consumption of a good or service increases, the demand for that good or service increases. As the price of a substitute in consumption of a good or service decreases, the demand for that good or service decreases. Ex: Pepsi or Mountain Dew are subsitutes good. When price of Pepsi increases the demand for Mountain Dew are going to increases because Pepsi are expensive now. 6.Population: As population increases, demand for goods and services increases. As population decreases, demand for goods and services decreases. 7. Number of buyers: As the number of buyers increases (decreases), the demand for a particular good or service increases (decreases). • Fundamental distinction between a movement along a demand curve and a shift of the demand curve A ''shift ''in the demand curve (Diagram 1) is caused by the change in one of the determinants of demand (which can be found above). A ''movement ''along the curve (Diagram 2) shows the change in the quantity demanded of a good in response to a change in price. Diagram 1 Diagram 2. Exceptions to the Law of Demand • ostentatious (Veblen) goods---A Veblen good is a good people would buy to show off their wealth and social class. In this case, if the price of a good--a yacht for example--increased, then people would get more of an incentive to buy it because they know they can afford it. Since the quantity for veblen goods increases when price increases, there is an upward sloping demand curve. • role of expectations--when people expect something to happen and then base their decisions upon their belief that that thing will happen, oftentimes their actions create the very thing they expected to happen. In short, it is a self-fulfilling prophecy, or a self-reinforcing feedback loop. * For example, if there is an expectation of future price increase--that expectation could increase present demand, leading to higher prices. * This effect can also work on goods that aren't only purchased for personal consumption, but also speculative ones, such as shares or property. * For example, the tulip mania that gripped Holland in the seventeenth century--because people expected that the tulip bulbs would be worth a great deal, they were willing to pay a great deal for them, making them in fact worth (at least for that bit of time) worth a great deal. • Giffen goods: Giffen goods are goods that feature upward-sloping demand curves due to the basic necessity of that good. An(not-true) example is bread. People with low incomes need bread to survive and buy a certain amount. They then spend their remaining salary on less important foods like cheese. An increase in the price of bread will result in an increase in demand due to people now having to spend more of their income on bread and forgetting about less important foods. Supply • Definition of supply: the quanity producers are willing and able to produce at different prices during a specific time period. amount of a good or service available for consumers to purchase. • Law of supply with diagrammatic analysis The law of supply states that as the price of a good rises, the quantity supplied of the good rises, and as the price of a good falls, the quantity supplied of the good falls, ceteris paribus. Determinants of Supply The determinants of supply are Input prices- If it costs more to produce each unit of a good because of higher input prices, supply will decrease. -Ex: If gas price increases, it would cost more to transport things around the country. Thus, making things more expensive when you get them because it cost more to make them now. Technology- If technology gets better then production and efficiency goes up which makes it easier to produce causing the supply to go up. More efficient technology also has the potential to lead to less pollution, which is often a problem in developing as well as developed countries. By increasing production efficiency, they can use less material and therefore less waste. Expectations about future price- If producers expect the price of a good to increase then they may hold back some of a good until the price does increase. This causes supply to decrease and low-and-behold price to increase. On the other hand, if suppliers expect the price of a good to decrease, the may produce and offer to sell more of that good at every price. As a result, the supply of the good increases and the price decreases, another self-fulfilling prophesy. Number of sellers- If the number of sellers increase so does supply because more people will be producing more to sell. Infrastructure- Better roads and transportation options usually makes it easier to transport goods. This enables suppliers to connect with more consumers, and supply increases. Easier transportation systems mean that in the long run they will profit more than they do now. Prices of Related Goods- Substitutes in production: If the price of a substitute good in production increases (decreases), suppliers will produce less (more) of the good for which there is a substitute, at all prices. Complements in production: If the price of a complementary good in production increases (decreases), suppliers will produce more (less) of the good for which there is a complement, at all prices. • Effect of taxes and subsidies on supply - If taxes are put on things that produce negative externalities, like carbon production (by burning coal) the supply of carbon would go down (which essentially is electricity) since it would cost the producers more to produce it, due to higher input prices caused by the tax. Taxes also decrease demand by lowering the amount of money people have to spend and by raising prices on the goods they wish to buy, therefore they will buy less. Thus taxes allow the government to control markets. -Subsidies: If the government wants the supply of a certain good to go up, they'd pay the producers in the form of subsidies so they have more money to produce more. • Fundamental distinction between a movement along a supply curve and a shift of the supply curve: Movement along the supply curve refers to one price change and one resulting quantity change (or vise versa); no determinants of supply are involved. A shift of the supply curve represents a change in the determinants of supply, and shift all prices and all quantities. Interaction of Supply and Demand • Equilibrium market clearing price and quantity: Also called the equilibrium point, this is the price at which the quantity that is demanded equals the quantity supplied. This point will provide the maximum satisfaction to both buyers and sellers, because it reflects the place where those buying and selling are at the best point of agreement and the price is most reasonable for both the buyers and the sellers. While the buyers would appreciate a lower price, and the sellers a higher one, the equilibrium price is the one that will maximize benefits for both. • Diagrammatic analysis of changes in demand and supply to show the adjustment to a new equilibrium Price Controls • Maximum price: Causes and Consequences *A maximum price is also called a price ceiling. A '''price ceiling' is when a price for a certain good has to be kept below a certain level. It may also lead to shortage and a black market. *The effect of a price ceiling changes how much of a good is sold, regardless of the demand for that good. Thus, a price ceiling often results in deadweight loss. A deadweight loss is the name given to the situation that occurs when supply can meet demand, but is limited to only a portion. If the number of goods produced exceeds this point, they become worthless, as the value is forced to lower than it would be sold unhindered. • Minimum price: causes and consequences *A minimum price is also called a price floor, and is set by the government to help prevent monopolies and externalities. *A price floor has no impact if it is set below the equilibrium point for that good, since markets automatically correct themselves and the price will just rise to eqiulibrium, as in Graph A *If a price floor is set above equilibrium, then a surplus occurs. This is because the price is too high so there will be a large quantity supplied but a smaller quantity demanded, as in Graph B. • Price support/buffer stock schemes seek to stabilize the market price of agricultural products by buying up supplies of the product when harvests are plentiful and selling stocks of the product onto the market when supplies are low. • Commodity agreements: International agreement designed to stabilize commodity prices in the interest of producers and consumers. They can include mechanisms to influence market prices by adjusting export quotas and production when market prices reach certain trigger price levels. They sometimes employ buffer stocks. Example: Price floors are often set above the equilibrium price on goods such as cigarettes or alcohol, which both have negative externalities. This forces people to pay more than the price would be in a free market, causing the price to more acurately reflect the costs of the goods to society. Category:Microeconomics Category:Economic Basics (AP)